Hedge fundsQ&A: Why look at Asian hedge funds?

Chief Investment Office GWM | 09 May 2019 3:41 pm BSTKarim Cherif, Strategist; Georg Weidlich, Strategist

• Question: Why look at Asian hedge funds?

• The short answer: to diversify geographically, get access toattractive risk-adjusted returns and potentially benefit froma rich alpha opportunity set.

• Evidence: Survey data suggests that hedge fund allocatorsincreasingly search for managers with an investment focusin Asia, especially China. For instance, a report by DeutscheBank points out that APAC is the most sought-after region in2019, with ca. 40% of respondents planning to increase theirexposure to the region. Similarly, a Barclays survey suggeststhat ca. 40% of allocators want to increase to APAC-basedmanagers. Some allocators highlight as a reason the needto diversify their holdings across regions, whereas others seea bigger potential for alpha generation in Asian markets ontop of an expected healthy beta contribution.

• Investment conclusion: Using hedge funds as a tool toinvest in Asia is attractive, in our view. Asia's higher marketvolatility requires an emphasis on risk management, which istypically a focus area of hedge funds. At the same time theenvironment in Asia bodes well for active management andhedge fund alpha generation.

Our CIO hedge fund series seeks to answer topical questions onthe hedge fund industry. Each issue offers a mixture of innovativequantitative research, an interrogation of academic and industrypapers, and engaging graphics to provide answers to pertinenthedge fund questions.

The last page of every Q&A report is a "What you need to know"section – a bite-size digest of recent performance and positioningstatistics and news on the hedge fund industry.

As always, feedback and thoughts on our reports are encouraged.We look forward to sharing our ideas and working with you.

Source: gettyimages

---------------------------------------------------------------------This report was written by Karim Cherif andGeorg Weidlich, part of your dedicated UBSGlobal Wealth Management CIO Alternativesteam.

This report has been prepared by UBS Switzerland AG. Please see important disclaimers and disclosures at the end of the document.

Asia and especially China offer attractive long term investment opportunities with limited correlation to other markets. However, market risk can be elevated and local expertise is required. Investors often see in Asia-focused hedge funds an efficient way to get exposure to the region while at the same time achieve attractive risk-adjusted returns.

Chinese markets are still very fragmented and dominated by retail investor flows. In addition,

while the number of listed companies is on the rise, sell-side analyst coverage remains limited

and information asymmetry is high. This creates pricing inefficiencies that hedge fund

managers can capture.

The hedge fund industry in China is still maturing. But with markets becoming more accessible

and liquid (for instance for building shorts) as well as increased manager professionalism and

discipline in the way they approach risk and capital allocation, investors are becoming more

familiar and comfortable with allocating to domestic managers.

Turn for "Chinese hedge funds in detail"

Three reasons why investors allocate to Asian hedge fund managers:

Q&A: Why look at Asian hedge funds?

?

0%

10%

20%

30%

40%

50%

60%

All Endowments/Foundations

Family Offices Fund of Funds Insurance Investmentconsultants

Pension Funds Private Banks

Asia Pacific China

Regional net allocation plans by investor type

38% of investors surveyed plan to increase their

hedge fund allocation to Asia-Pacific and China.

Source: Deutsche Bank Alternative Investment Survey 2019, UBS, as of

May 2019. Data: A survey of 425 investors who invest or advise on

$1.7 trn of hedge fund assets.

1

3

2

Hedge funds

2

ögeor

Chinese hedge funds in detail

Hedge funds in China Chinese stock market structure …

… creates a richer alpha opportunity set

Due diligence however is essential

Source: Morgan Stanley Prime Brokerage, UBS, as of May 2019. Data: Survey of

~200 institutional investors representing about USD 520 bn in hedge fund assets

Source: Asset Management Association of China

The Chinese stock market is the second largest in the

world by market capitalization and turnover is close to

that of US markets.

Yet, it exhibits large information asymmetry and a

range of inefficiencies.

80% of A-shares companies are covered by less than

five analysts (vs 27% in the US). Only 40% of A-shares

beat expectations (vs 76% in the US). 80% of the

flows are dominated by retail investors.

Chinese market inefficiencies in numbers Number of private security funds in China

China's private fund industry (hedge funds, private

equity, venture capital) represents about 25,000 firms

and 12.7 trn yuan in assets (~1.9 trn USD).

Asset concentration is high with top 20% of the funds

holding 90% of the industry's AuM. About 240 funds

have AuM of more than USD 1.5bn.

The majority of funds are long/short equity managers,

followed by macro and relative value funds. Investors

can choose between onshore or offshore funds.

Top reasons for investing in Chinese and Asian funds,

% of respondents allocating to Asia in 2019

Risk management and operational robustness of

Chinese hedge funds is often not at the same level

as their western peers.

Transparency, compliance, risk of fraud are areas

investors need to pay particular attention to when

selecting a fund.

Trusted local advisers and a well-diversified

portfolio are often an efficient approach to

mitigate the impact of some of these risks.

Turn to for "what you need to know" from

May/June

# of funds that failed to renew AMAC registration in

2017/2018 due to operational reasons among others

Such pricing inefficiencies in Chinese financial

markets are arbitrage opportunities that a hedge fund

manager can take advantage of to generate alpha.

In an MS survey, 76% of investors allocating to China

cited "the higher opportunity to generate alpha" as a

primary motivation to seek exposure.

Winning strategies typically rely on a strong local

network to source investment ideas. Poor data quality

also puts emphasis on collecting, cleaning, and using

accurate information especially for more

quantitatively-orientated managers.

Source: Bloomberg, Thomson Reuters, UBS, as of May 2019

76%

25% 23% 18%

13% 5%

0%

20%

40%

60%

80%

100%

Higheropportunity togenerate alpha

Growing talentbase

Undervaluedmarket

Diversify &increase

internationalexposure

Lack of alpha inother regions

Strong historicalperformance

Data (2000- 2015)

not sure whether

we should have

active trading

there

25k Source: Asset Management Association of China (AMAC)

>400

Hedge funds

3

China L/S ratio near peak

Hedge funds net bought

Chinese equity since late

2018 and the China L/S ratio

is now at 2.8. This is in the

93rd percentile since 2012. A

sizable portion of this

increase can be attributed to

net buying of A-shares.

93rd

percentile

Source: Morgan Stanley, as of May 2019

Performance

1.6% in April

Performance numbers from

Hedge Fund Research for

April point at a strong month

for the industry (1.6% m/m,

7.2% YTD through April),

ranking in the 83rd percentile

since 2010.

Winners and losers EH funds charge ahead

Equity hedge funds have

regained last year's losses

YTD through April and are

up 9.4%. Other directional

equity strategies also fared

well this year, such as

activists (12.3%) and special

situations managers (9.2%).

Positioning

In the news

Fund openings and

closures

Japan as a potential growth market for hedge funds

Hedge funds may become more prominent in Japan. Firstly, Japanese pension funds

are moving to non-traditional assets, in search of the returns required for their

beneficiaries as they struggle with near-zero bonds yields at home and a fast aging

population. Secondly, Tokyo officials plan to set up their town as a financial hub. In an

attempt to attract hedge funds, the registration process was eased and a emerging-

manager program to aid new firms with some of their initial expenses was created.

Slowly, this seems to be bearing fruit as eight new funds launched in the past 12

months and established hedge funds plan to open offices in Japan.

Reported by bloomberg.com on 2 April.

Activism has a new incumbent while it becomes more mainstream

In the first quarter of 2019, 57 activist campaigns were launched globally, in line with

multi-year averages. Of these, Starboard Value launched the most, targeting a total of

seven companies as diverse as eBay, Bristol-Myers Squibb (BMS) and the pizza chain

Papa John's. By number of campaigns they overtook Elliot Management which was the

most prolific activist for the previous seven quarters. Meanwhile, the strategy is

increasingly getting support from traditional asset managers, with recent examples

including Wellington Management who spoke out against BMS's planned acquisition

of Celgene and M&G Investments that argued for refreshing the board of directors of

the chemicals company Methanex.

Reported by ft.com on 26 March and 10 April and by Lazard's Review of Shareholder Activism Q1 2019. All images: UBS

What you need to know: May/June

9.4%

6.4%

4.1% 4.9%

0%

2%

4%

6%

8%

10%

Equity Hedge Event-Driven Macro/Trading Relative Value

Source: Bloomberg, UBS, as of May 2019

Hedge funds

4

Non-Traditional Assets

futures (collectively, alternative investments).

funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund

investment fund as a supplement to an overall investment program.

these strategies:

investments.

focus on all strategies at all times, and managed futures strategies may have material directional elements.

with the ability to qualify for favorable treatment under the federal tax laws.

investment.

for securities denominated in U.S. dollars, changes in the exchange rate between the U.S. dollar and the issuer’s “home” currency

Hedge funds

5

Appendix

UBS Chief Investment Office's ("CIO") investment views are prepared and published by the Global Wealth Management business of UBSSwitzerland AG (regulated by FINMA in Switzerland) or its affiliates ("UBS").The investment views have been prepared in accordance with legal requirements designed to promote the independence of investmentresearch.Generic investment research – Risk information:This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment orother specific product. The analysis contained herein does not constitute a personal recommendation or take into account the particularinvestment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions.Different assumptions could result in materially different results. Certain services and products are subject to legal restrictions and cannotbe offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressedin this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express orimplied, is made as to its accuracy or completeness (other than disclosures relating to UBS). All information and opinions as well as anyforecasts, estimates and market prices indicated are current as of the date of this report, and are subject to change without notice.Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of usingdifferent assumptions and/or criteria.In no circumstances may this document or any of the information (including any forecast, value, index or other calculated amount("Values")) be used for any of the following purposes (i) valuation or accounting purposes; (ii) to determine the amounts due or payable,the price or the value of any financial instrument or financial contract; or (iii) to measure the performance of any financial instrumentincluding, without limitation, for the purpose of tracking the return or performance of any Value or of defining the asset allocation ofportfolio or of computing performance fees. By receiving this document and the information you will be deemed to represent and warrantto UBS that you will not use this document or otherwise rely on any of the information for any of the above purposes. UBS and any of itsdirectors or employees may be entitled at any time to hold long or short positions in investment instruments referred to herein, carry outtransactions involving relevant investment instruments in the capacity of principal or agent, or provide any other services or have officers,who serve as directors, either to/for the issuer, the investment instrument itself or to/for any company commercially or financially affiliatedto such issuers. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS and its employees maydiffer from or be contrary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since themarket in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult toquantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas,units, divisions or affiliates of UBS. Futures and options trading is not suitable for every investor as there is a substantial risk of loss, andlosses in excess of an initial investment may occur. Past performance of an investment is no guarantee for its future performance. Additionalinformation will be made available upon request. Some investments may be subject to sudden and large falls in value and on realizationyou may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverseeffect on the price, value or income of an investment. The analyst(s) responsible for the preparation of this report may interact with tradingdesk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information.Tax treatment depends on the individual circumstances and may be subject to change in the future. UBS does not provide legal or taxadvice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with referenceto specific client's circumstances and needs. We are of necessity unable to take into account the particular investment objectives, financialsituation and needs of our individual clients and we would recommend that you take financial and/or tax advice as to the implications(including tax) of investing in any of the products mentioned herein.This material may not be reproduced or copies circulated without prior authority of UBS. Unless otherwise agreed in writing UBS expresslyprohibits the distribution and transfer of this material to third parties for any reason. UBS accepts no liability whatsoever for any claimsor lawsuits from any third parties arising from the use or distribution of this material. This report is for distribution only under suchcircumstances as may be permitted by applicable law. For information on the ways in which CIO manages conflicts and maintainsindependence of its investment views and publication offering, and research and rating methodologies, please visit www.ubs.com/research.Additional information on the relevant authors of this publication and other CIO publication(s) referenced in this report; and copies of anypast reports on this topic; are available upon request from your client advisor.Important Information about Sustainable Investing Strategies: Incorporating environmental, social and governance (ESG) factorsor Sustainable Investing considerations may inhibit the portfolio manager’s ability to participate in certain investment opportunities thatotherwise would be consistent with its investment objective and other principal investment strategies. The returns on a portfolio consistingprimarily of ESG or sustainable investments may be lower than a portfolio where such factors are not considered by the portfolio manager.Because sustainability criteria can exclude some investments, investors may not be able to take advantage of the same opportunities ormarket trends as investors that do not use such criteria. Companies may not necessarily meet high performance standards on all aspectsof ESG or sustainable investing issues; there is also no guarantee that any company will meet expectations in connection with corporateresponsibility, sustainability, and/or impact performance.Distributed to US persons by UBS Financial Services Inc. or UBS Securities LLC, subsidiaries of UBS AG. UBS Switzerland AG, UBS EuropeSE, UBS Bank, S.A., UBS Brasil Administradora de Valores Mobiliarios Ltda, UBS Asesores Mexico, S.A. de C.V., UBS Securities Japan Co.,Ltd, UBS Wealth Management Israel Ltd and UBS Menkul Degerler AS are affiliates of UBS AG. UBS Financial Services Incorporated ofPuerto Rico is a subsidiary of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a reportprepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US person in the securitiesmentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and not through anon-US affiliate. The contents of this report have not been and will not be approved by any securities or investment authorityin the United States or elsewhere. UBS Financial Services Inc. is not acting as a municipal advisor to any municipal entityor obligated person within the meaning of Section 15B of the Securities Exchange Act (the "Municipal Advisor Rule") andthe opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of theMunicipal Advisor Rule.External Asset Managers / External Financial Consultants: In case this research or publication is provided to an External Asset Manageror an External Financial Consultant, UBS expressly prohibits that it is redistributed by the External Asset Manager or the External FinancialConsultant and is made available to their clients and/or third parties. For country disclosures, click here.Version 04/2019. CIO82652744© UBS 2019.The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

Hedge funds

6